Snap Inc (NYSE:SNAP) will mostly likely go down as 2017’s most-highly anticipated IPO, but perhaps one of its most disappointing, too. After pricing at $17 per share, shares opened at $24 — a 40% gain from its offering pricing — to get things started. Two months later, though, we find SNAP stock trading lower, currently around $22.
So is it finally time to buy Snapchat parent, Snap? I don’t think so.
The reasoning goes beyond the stock’s ~8% decline from its Day 1 open and its high valuation. A big part of it is from competition and potential lack of focus.
Snap’s venture into Spectacles — the flawlessly executed introduction of $130 “smart” sunglasses — was excellent. Management did a fantastic job. But a few months later, there were reports that SNAP could be working on a drone. While it would be great to see it pull off another Spectacles repeat, I’m cautious of a software company getting into hardware.
Investors typically cheer when a hardware company — traditionally commoditized products with low profit margins — gets into the higher margin software business. That’s why Snap making the opposite move seems unattractive. They could pull it off, but I’m skeptical. We only need to look as far as GoPro Inc (NASDAQ:GPRO) to see why this business model seems unattractive.
Competition and Valuation
Even worse than reports — in which accuracy can be quite suspect — is the competition. When it wants in, Facebook Inc (NASDAQ:FB) has found little resistance in new businesses. It has blatantly copied some of Snapchat’s top features to win over users on its Instagram platform. Unfortunately for Snap, this strategy is working wonderfully for FB.
Facebook’s got size and scope, with 1.2 billion monthly active users (MAUs) on Messenger, 1.3 billion daily active users and 1.8 billion MAUs on its Facebook platform and 700 million MAUs on Instagram. With that kind of reach, FB can easily overpower smaller competition like Snap and Twitter Inc (NYSE:TWTR).
In this regard, SNAP Stock isn’t exactly a slam dunk when it comes to an investment. Unfortunately, the same can be said for its valuation. Revenue growth for 2018 is expected to grow a whopping 98% from 2017’s $1.03 billion. That’s impressive. But analysts still expect Snapchat to lose 51 cents per share this year and 30 cents per share in 2018.
Unprofitable alone doesn’t mean unworthy for Snap as an investment. Plenty of other stocks don’t turn a profit and still go higher.
Instead, it’s the valuation that’s the big turnoff. Currently valued at $25 billion, Snap trades at ~62 times last year’s sales. Worse yet, it trades at about 25 times 2017 revenue and 12.5 times 2018 sales.
Trading at 25 times this year’s sales is nearly unfathomable. It’s an astronomically high price to pay for a property, regardless of its growth.
Instead of Snap
While Facebook hasn’t grown its revenue quite as fast as Snap, it’s still been impressive. Analysts expect 37% sales growth this year and 27% growth in 2018. FB has boosted sales by 50% or more in five straight quarters. It hasn’t missed an EPS estimate in 13 quarters and only missed revenue estimates once in that period.
Although it trades at 16 times last year’s sales (11.5 times 2017 sales), FB is profitable. In fact, unlike SNAP, it’s highly profitable. Analysts expect 28% earnings growth this year and 23% growth over the next five years.
So what’s the bottom line? Snap reports earnings on May 10 after the bell. While there could be an upside reaction and push back to its 52-week high of $29.44, doesn’t mean investors should buy it. The valuation is too high and competition too stiff.
Better yet, there’s a more attractive candidate out there, even though FB has rallied hard.
Bret Kenwell is the manager and author of Future Blue Chips. He can be contacted on Twitter via @BretKenwell. As of this writing, Bret Kenwell held no positions in any security mentioned.
